Credit Loss Ratio

Posted in Finance, Accounting and Economics Terms, Total Reads: 1040

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Definition: Credit Loss Ratio

Credit loss ratio is defined as the ratio of current credit related losses to the current par value or original par value of the mortgage backed security (MBS). Mortgage backed securities are the securities that are backed up by mortgages or group of mortgages.

These kind of securities are the safest. These securities are sure to be redeemed. For the purpose of their principal and interest payment these mortgages or group of mortgages will be used in case the issuers default. These securities are risk free assets which give investors nothing to be worried about.

Formula:

Credit loss ratio = Current credit loss / Mortgaged backed security

Advantage

This kind of ratio is very advantageous for the issuer agency. As this ratio measures the amount of risk asset is exposed to and gives the issuer agency to see what kind of actions and policies they need to undertake in order to mitigate the loss in case the risk is high.

This kind of ratio is not of much interest to the investors. As already mentioned they get the securities which are backed up by the mortgage (secured)

Example:-

Suppose Indian Government issues 8% treasury bonds with 25 years of maturity.

These bonds are backed up by a wholly owned public undertaking.

Now, the investors are sure to receive 8% rate of interest annually and the principal amount at the end of maturity.

But the Indian government, would like to know how much risk exposed is their mortgage. The credit loss ratio will help them to analyse the amount of risk their mortgages are exposed to and further decide the policy they would like to undertake in order to mitigate the risk.

Hence, this concludes the definition of Credit Loss Ratio along with its overview.

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